Looking into 2020: Industry Alpha Trends

Happy New Year! We hope you enjoyed the holidays with your family and are rested, recharged, and ready for 2020.

To kick off the new year, we continue our analysis on alpha-driven stocks. This week, we’ll extend that analysis to the Industry Group level, as we uncover alpha trends that just might surprise you. We’ll also provide our market and factor update for the past two weeks.

‍Industry-Level Alpha-Driven Stock Analysis

‍As a reminder, we define “alpha-driven” stocks as securities where 2/3rds (67%) or more of total volatility is idiosyncratic. In other words, the majority of their risk is company-specific, and not subject to external forces (geopolitical or economic news, sector moves, etc). We call these alpha-driven moves “idiosyncratic risks” or “specific risks".

For this exercise, we used the Russell 3000 since Jan 2018 as our universe. If you recall, we had observed an overall decrease in higher alpha names within the index during this period. We also noted fewer stock picking opportunities in the midcap and large cap segments of the Russell 3000.

Now, we’ll take a look at alpha trends within three distinct buckets of industry groups (defined using GICS level 2 classification) that we’ve constructed. Our methodology here is to simply measure the number of names with over 67% specific risk as a percentage of all of the names in the respective industry group, on the first of each month, from 1/1/18 to 12/31/19.

‍Consistent High (Low) Alpha

The chart above shows the industry groups that, accounting for the broad decrease in alpha-trends in the market exhibited a consistent low or high factor/alpha trend throughout the period.

There’s little surprise here as the Utilities, Transportation, Banks, Energy, and RealEstate groups have never been considered to be alpha-driven, meaning only a consistently small percentage of the names are inherently high-alpha. That said, the dispersion of the percentage of alpha-driven names in these sectors appears to have significantly tightened in 2019, with no industry group having more than 30% alpha-driven names in December.

At the same time, the Pharmaceuticals, Biotech, & Life Sciences group has been consistently alpha-driven, since so much of the group’s success is tied to the success of individual drugs/therapeutics.

Alpha Trending Down

In this chart, we can see how some previously high-alpha groups have become more factor driven over time. This might be surprising to some since the Media, Tech Hardware & Equipment, Healthcare Equipment, and especially the Software & Services groups have typically been associated with high alpha. Much of the decline in alpha for these industries can be attributed to increased exposure to the Growth/Momentum factor in the 2019 bull rally.

‍Alpha Trending Up (Recently)

After bottoming out in percentage of alpha-driven names in Jan-Mar 2019, the Food & Staples Retailing, Food, Beverage, & Tobacco, Retailing, and Telco Services have had the biggest positive alpha gains throughout this period (40-70%). We consider these trends to be somewhat surprising, especially given that they generally bucked the broader downward trend the market.

US & Global Market Summary

US Market: 12/20/19 - 1/02/20

• The market extended the 2019 rally into the new year, drifting upwards through the slow holiday period until Friday’s news that a US drone had killed Iran general Qassem Soleimani, immediately ratcheting up tensions in the Middle East. The major benchmarks ended down on Friday (not captured in above chart), while oil prices were on the rise.
• The ISM Manufacturing PMI fell to 47.2 in December vs. 49 expected, indicating that US manufacturing continued to contract last month. The New Orders index tallied its lowest reading since April 2009.

Factor Update: US Model

• Value continued its big rally, up almost one full standard deviation over the past couple of weeks.
• Volatility also saw positive normalized gains, and remains an Overbought factor at +1.59 SD above the mean.
• Profitability ticked back up as it heads back towards neutral territory.
• Momentum peaked at +1.31 SD above the mean on 12/9 and has since seen a steep reversion, now at 0.52 SD above the mean.
• Earnings Yield had exited Oversold territory on 12/20 but has since slipped back down on a normalized basis, sitting at -1.09 SD below the mean.
• Growth was the biggest loser, down 0.44 standard deviations as it looks poised to exit Overbought space in the near term.
• US Total Risk (using the Russell 3000 as proxy) fell by 0.42%, although we’ll wait to see the impact of the Iran news next week.

‍Factor Update - Worldwide Model

• Global Profitability continued its rally, up +1.47 standard deviations in the past two weeks and squarely in Neutral territory now.
• Exchange Rate Sensitivity gained almost half a standard deviation and is now essentially neutral.
• Value is approaching Extremely Overbought territory at +1.91 SD above the mean.
• Volatility saw some gains as it edged towards Overbought space, while Market Sensitivity declined a bit.
• Earnings Yield fell 0.44 standard deviations and is now an Oversold factor.
• Momentum continued to revert away from its recent peak of +1.10 SD above the mean on 12/11, now sitting in Neutral space.
• Global Risk (using the ACWI as proxy) decreased by 26bps.

Regards,
Omer